Market view: MPC forecasts ‘still too optimistic’
In its quarterly Inflation report published today (17 May), the Bank of England gave a moribund prognosis of the UK economy this year, warning that inflation will remain high for longer than was previously thought and that growth will be weaker than previously expected.
In fact, the Bank said inflation is likely to remain above its 2 per cent target for at least another year, roughly six months longer than was forecast in the last report in February. The Bank also revised down its GDP estimate for 2012 to 0.8 per cent.
According to Vicky Redwood, chief UK economist at think-tank Capital Economics, “sticky inflation” means that the Monetary Policy Committee sees little scope for further quantitative easing. However, Ms Redwood says this could change as MPC forecasts remain “too optimistic”.
Ms Redwood said: “Even after today’s downgrades, the MPC’s forecasts still look too optimistic – note that the committee still isn’t incorporating the more extreme risks associated with the eurozone.
“There are plenty of reasons, not least the extremely weak pay growth shown in this morning’s labour market figures, for core inflation to fall further. Accordingly, we still expect QE to be restarted later this year.”
Ruth Lea, economic adviser to Arbuthnot Banking Group, also does not rule out further QE but said that a lot depended on the eurozone crisis.
She said: “If the eurozone crisis erupts again, and it looks as if it has, the Bank will step in and help the banks by buying more gilts, rather than corporate debt. The Bank is ready to respond to another crisis.”
Ms Lea said: “The Bank may still be on the optimistic side. For the last couple of years, the Bank has been over optimistic and are losing credibility for a reasonable forecasting record.”
Stephen Jones, Kames Capital’s joint head of fixed income and manager of the Kames Inflation Linked Fund, believes that the report “remains broadly” unconcerned around inflation in the UK.
Mr Jones said: “Sir Mervyn King appeared as dovish as ever, ready to support the UK with whatever action is necessary, even over the near term when inflation will remain above the Bank of England’s target.
Rupert Watson, head of asset allocation at Skandia Investment Group, pointed out that the UK is reported to have shrunk by 0.2 per cent in the first quarter of this year, but that the Bank’s report suggests the UK grew “modestly” at the start of this year.
He said: “The UK’s GDP reports are subject to significant revision, often a long time after the fact. When there is a difference between the early GDP reports and the business surveys, the business surveys usually turn out to be more accurate.
“That the data is likely to be revised higher will not provide much comfort to the government since by the time it does few will care.”